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IMF warns income disparities can hurt economies

WASHINGTON—The International Monetary Fund warned Thursday that wide income inequality can slow economic growth and is proposing ways to reduce it.

Its recommendations include: Raising property taxes. Taxing the rich more than others. Raising the eligibility age for government retirement programs.

Such proposals have typically encountered stiff opposition from policymakers. IMF officials say it is up to individual countries to decide whether and how to try to reduce income disparities. But if they do, its report released Thursday highlights ways it says governments can use tax and spending policies to reduce inequality without inhibiting growth.

The proposals are the latest sign of the IMF's growing concern about income inequality. It's an unusual focus for a global lending organization best-known for providing loans paired with strict budget cuts.

Thursday's report puts the weight of the IMF behind the notion that large wealth gaps can depress growth, a move welcomed by advocacy groups for emerging economies.

Similarly, a survey by The Associated Press late last year found that a majority of economists think income inequality in the United States is weakening its economy. Middle-income consumers are more likely to spend extra income than wealthier households are. As a result, stagnant middle-class income can depress consumer spending and overall growth.

"The IMF is coming kind of late to the party in terms of worrying about inequality and what can be done about it," said Nancy Birdsall, president of the Center for Global Development.

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"But they are a big player, so we're glad they came to the party."

Inequality has worsened in most countries in the past three decades, the report said. In the United States, the share of income that's gone to the richest 1 percent surged to 19 percent in 2012 from 8 percent in 1980, the IMF's report noted.

Similar gains have occurred in other "English-speaking countries," the report said, and in China and India. By contrast, the share of income that's gone to the top 1 percent in Europe and Japan has scarcely risen.

Income disparities are fueling rising concern around the world and protests in countries such as Brazil and Turkey. Many countries have sought the IMF's help in addressing the issue, the report said.

Government tax and spending policies can be effective in reducing inequality, the report said. Such policies have lowered the income gap by an average of one-third in advanced economies, mostly because of money transferred to the poorest households.

Last month, an IMF research paper concluded that countries with steep income inequality were more likely to have briefer and weaker periods of economic growth. It also argued that efforts to redistribute income don't necessarily hinder economic expansion.

That runs counter to traditional thinking, which generally assumes a trade-off between economic growth and efforts to reduce inequality. Under this view, a higher tax rate on the wealthy or higher spending on social welfare, while it may reduce income inequality, would likely depress growth.

Christine Lagarde, the IMF's managing director, said last month that income inequality "can have pernicious effects" and that "careful design of tax and spending policies can help reduce inequality."

The IMF's report makes numerous recommendations including these:

— Progressive income taxes, under which the wealthier pay a higher proportion of their pay, are more effective in redistributing income than flat tax rates are. Yet the median top income tax rate globally has fallen from 59 percent to 30 percent in the past three decades, the report said. And 27 countries, mostly in Eastern Europe, have adopted flat taxes since the mid-1990s, the IMF said. Still, top rates above 50 percent or 60 percent can discourage wealthier people from working and reduce growth, it said.

— Developing countries should expand the use of income taxes to reduce reliance on sales taxes, which tend to hit the poor hardest. In many emerging economies, only a sliver of wealthy households pay any income tax. In Pakistan, just 500 households do, Birdsall said. In the past, the IMF has recommended that governments adopt sales taxes because they are easier to administer, Birdsall noted.

— Advanced economies could reduce tax breaks that are more likely to benefit the wealthy. The report specifically cited the mortgage-interest tax deduction in the United States.

— Governments should ensure that poorer citizens have access to higher education and health care. More education can help low-income people earn more and move up the income scale, the report said.

— Many advanced economies could raise more revenue from property taxes. Such taxes on homes and land can lower inequality because they fall heaviest on the wealthiest people.

— Taxes on financial wealth are mostly ineffective, because those assets can be shifted overseas to avoid taxes.